A war continues to rage quietly in the mutual fund industry.
At the moment, Vanguard Group and Fidelity Investments are in the heat of battle, fighting to claim the title of the provider with the least expensive index mutual funds.
For years, Vanguard arguably has held that title. But as of Aug. 1, Fidelity has laid claim to it by slashing the expenses on 14 of its index funds.
This comes about a year after Fidelity reduced the expenses on more than two dozen of its funds — and about three months after Vanguard fired back by reducing the expenses on dozens of its funds.
The ultimate winner in the index fund war, however, is not a mutual fund company or any other financial institution. It’s investors like you and me.
Understanding mutual fund expenses
As we explain in “Money Lingo You Need to Know for Financial Survival,” the cost of owning a share of a mutual fund — the operating expense — is known as an expense ratio. It’s expressed as a percentage of the amount of money you invest in a mutual fund.
If you hope to retire comfortably, it’s critical to invest in funds with low expense ratios. These percentages might seem small, but they can add up over time — costing many people a bigger chunk of their nest eggs than they realize.
Let’s take a look at the costs of two well-known stock index funds offered by Fidelity: the Fidelity 500 Index Fund and the Fidelity Total Market Index. Both have expense ratios of:
- 0.09 percent for investor shares, which is unchanged but was already less than Vanguard’s equivalent. (Currently, investor shares of the Vanguard 500 Index Fund have a 0.14 percent expense ratio, and those of the Vanguard Total Stock Market Index Fund have a 0.15 percent expense ratio.)
- 0.035 percent for premium shares, which is down one basis point, making them cheaper than Vanguard’s equivalent. (Currently, premium shares — known as “admiral” shares at Vanguard — of Vanguard’s 500 Index Fund and Total Stock Market Index Fund have 0.04 percent expense ratios.)
Besides expense ratios, the only difference between Fidelity’s investor and premium share classes is the minimum required investment amount: $2,500 and $10,000, respectively.
Other stock index funds offered by Fidelity that have newly reduced expenses include the following, all of which now have expense ratios of 0.17 percent for investor shares and 0.05 percent for premium shares:
- Fidelity Large Cap Growth Index Fund
- Fidelity Large Cap Value Index Fund
- Fidelity Mid Cap Index Fund
- Fidelity Small Cap Index Fund
Fidelity has also reduced expenses on a number of its other funds, including bond index funds.
Index funds vs. active funds
There are two main types of mutual funds:
- Actively managed mutual funds are run by financial professionals who decide which individual stocks or bonds to buy and sell within the fund. They aim to outperform stock market indices — and charge higher fees for their effort.
- Passively managed mutual funds, often referred to as index funds, simply aim to mirror a stock market index such as the S&P 500. Fees are therefore minimal.
The takeaway here isn’t whether to invest with Fidelity or Vanguard. Investors at either company will do well for themselves, as expense ratios at both companies will presumably continue to fall as more folks continue to flock to index funds.
Instead, the key lesson is to seek out mutual funds with the lowest possible expenses for your retirement portfolio — regardless of where you invest. That means index funds rather than active funds. Vanguard and Fidelity just happen to offer index funds more cheaply than most brokerages.
To learn more about how your portfolio could benefit from index funds, check out:
- “9 Tips Beginning Investors Must Know“
- “5 Simple Ways to Invest Your Retirement Savings“
- “Ask Stacy — How Do I Invest in a Mutual Fund?“
What do you make of the trend of mutual fund companies lowering fees? Share your thoughts below or on our Facebook page.
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